Raghuram Rajan Committee on Financial Sector reforms

I have got a few queries regarding which website can one download the Raghuram Rajan chaired Committee on Financial Sector Reforms (CFSR) ?

The report is placed on the Planning Commission website and can be downloaded from here. I am just going through the report and so far the recommendations have been usual well-known ones. I will add my comments if I find something interesting.

Also there have been questions over the location of MIFC report. It can be downloaded from here. My comments here.

Addendum:

My comments

1. I just wanted to raise this issue which is not related to the report but on the poor research capabilities at India’s leading institutes. I did a random check on the references mentioned at the end of the chapters. I usually check the references to pick papers which I have not read or am unaware of but is important to read. Most of my papers I point out on this blog are a resultof this exercise.

As it is a draft report, references are mentioned in just three chapters:

Chapter 2 The Macro-Economic Framework and Financial Sector Development

Chapter 3 Broadening Access to Finance

Chapter 4 Leveling the Playing Field

In all three, I didn’t find a single paper from India’s elite business schools. I had earlier raised this point that these institutes don’t point to their research. You hardly come across any of their papers mentioned as a reference in any paper/any topic on economics.

But on checking India specific reports and that too this one on finance (which is a speciality in most of these places) and not finding any reference is disappointing. Raghu Rajan himself is from one of the elite institutes and surely wouldn’t give their research a miss. I hope I get to see some papers in the other chapters’ reference list (if it is added that is).

Though, the institute I had mentioned about has a few papers in Chpater 3, which is their forte anyways. Someone needs to fix this. It is not amusing anymore.

2. I have added some comments on the inflation targeting mandate suggested by the report.

3. Chapter two has a discussion on macroeconomic issues in India. Unlike most reports on financial sector in India, this one understands that macroeconomics is as important. The chapter focuses on two main issues- capital account convertibility/controls and whether RBI should focus alone on inflation targeting.

The committee proposes both CAC and IT. I have written on IT issue earlier as well. As far as capital flows are concerned, despite the mixed evidence on whether it works or not, the committee says India should adopt it. If benefits are more, so are the costs.

I am disappointed as there is hardly any empirical evidence. Why can’t the committee add empirical evidence on the Indian experience. (I have some basic idea on capital flows based on Rodrik’s paper here).

I am not against capital flows or IT but we need to make case for it. You simply can’t review literature and suggest ideas that belong to the developed economies. And we should expect some empirical evidence from such an eminent panel. We all want to become developed but the path isn’t as straight forward as it is made out to be. Most countries that have moved forward have charted their own path of growth.

Let me read the other chapters as well.

(15/7/2008) I think all the proponents of an IT frameowrk in India should read the paper by Otmar Issing

4. Chapter 3- Broadening Access to Finance : This chapter is on Financial inclusion. It is quite a good one detailing what has worked and what hasn’t in financial inclusion in India.

It is actually quite balanced as it says though the policies for financial inclusion have been well intended, they have not delivered as per expectations. (Usually, we find research pretty biased against India’s financial inclusion policies. Though, I came across this paper which says the policies led to lower poverty.)

Hence, there is a need for improvement. The chapter suggests setting up special small local banks, rethink on priority sector lending/subsidies ( I liked the idea of creating a market for Priority sector certificates) , use technology etc.

Though, the chapter is more on supply side issues (expansion of services) and contributes little in terms of addressing demand (why people don’t come forward) issues. I am not sure whether that should be the only way.

Financial products/services are different from the usual products because of information asymmetry and the poor is more conscious of the asymmetry because of volatile incomes. Hence, though finance may help to lower his income volatility, he is not sure of availing the service. The chapter does mention financial literacy, but is just a small para at the end.

CFSR should have looked more into findings of behavioral economics/ finance. They had the best brains behind the study and am sure we could have come with more India centric demand ideas than pure suppy approach. The pure supply approach is costly and takes a lot of time. Many a time using BF/BE we realize the solution could be more simpler. I had mentioned about this paper where some ideas have been mentioned.

Though, the chapter (Page 29) does use BF/BE mention that cash transfers should be automatically transferred to a bank account electronically (the default should be the bank account) so that a person has to come to the bank and get the award. But, that is the only example. CFSR could have expanded the findings. I frankly don’t know why Policy documents ignore BE/BF. It has so much to offer.

5. Chapter 4: Leveling the Playing Field: This chapter goes back to the first few lessons of microeconomics – competition is good. It says people should get good quality financial services and this should not depend on some special privilieges given to certain firms namely public sector.

The chapter’s main idea is that certain firms and financial products are favored than others as rules and regulations have been framed in a manner which puts them in a beneficial place. Instead of tweaking the regulations further, the authorities should level the playing field so that anyone can offer financial services as long as he can compete with the others.

6. I have not been able to post any further comments on the report. I did manage to read chapter 5 and 6. Chapter 5 is on improving efficiency in markets and Chapter 6 is on regulation.

Chapter 5 has a chapter called – Are financial markets casinos? Despite all the good reasons of having efficient financial markets, the common man (on whom the report is targeted) has some other ideas. The committee members need to visit small towns where equity culture is thriving (atleast was till the markets were rising). In all these towns it is much like a casino with people glued to screens monitoring the swings very closely. If you them what the compamny does, the large part will not have a clue. Look, this does not mean that financial markets are casinos. But, pointing to a reality.

[…] It is also a season for committee reports (which are really difficult to read given the time) – Rajan committee on financial sector, Radhakrishnan report on indebtedness, Services Sector, Interest Rate Futures, Currency […]

I wish to share my comments I submitted to Committee for Financial Sector Reforms on its draft report during the seminar held at Mumbai on 12th June 2008. Please find it as follows –

With due regard to all CFSR members, I would like to say that the draft report is very comprehensive and it was not so easy to comment over it. The committee has indeed made sincere and focussed attempt to do justice with the assignment given by the planning commission. In the light of the available sources of information, it really made some very genuine proposals.

I hope the committee will certainly revisit the pointed areas and find it worth while writing the final report.

A. Micro Economic Framework
1. Money itself is a medium of exchange, facilitating economic transactions and denotes a price value of real output. Money itself is not a product. Whereas banking and financial services are real services promoting economic transactions and should have prices. There are two ways to recover the cost of financial services; either by fixing a rate of interest as price of finance; or by receiving proportionate share in outcome of financial services (i.e. profit). Interest payable on debt finance is a part of capital cost and increases cost of outputs, resulting increase in prices (inflation). Whereas equity finance is not considered as cost factor, and the aim is to share the profit, without increasing the price level, rather promoting profit sharing and bridging economic disparities. Using ‘interest’ as a tool to control inflation works to control liquidity and financial transactions, but does not provide anti inflationary monetary base, whereas equity based deposits and finances restrict inflation and promote equitable distribution of income and wealth, thus providing stability and inclusive growth. So, to control inflation and to stabilize financial market we need to promote equity based financial transactions.

2. It is required that the proposed Financial Development Council (FDC) and Financial Sector Oversight Agency (FSOA) should have close coordination with the Planning Commission so that it should work according to long term plan and not undertake any politically motivated agenda on priority or approve anything harmful for financial health of the nation.

3. Considering current recession in USA market, and China’s own requirement of capital inflow, we have to look for Capital Market from Oil Producing Countries for long term sustainable capital inflow for India. But to enable FDI from Oil Producing countries, we may have to open doors for Islamic Banking and Finance in India. Strategic promotion of Islamic Banking by Indian Regulators may open options to have our investments in petroleum resources; reciprocally FDI in our agricultural and unorganized sector.

B. Developing Banking and Finance for the unorganized Sector
4. We need to consider the nature of financial holdings required for our unorganized sector where the majority are poor and do not have the capacity to undertake financial risks nor have collaterals to provide. Debt finance through Banks and formal financial institutions do not suit the poor and vulnerable in unorganized sector; thus they should have access to equity finance instead of debt finance so that financial risks do not result in extra pressure on them.

5. The Business Correspondent model should be enhanced to enable BCs to provide information about equity deposits and finance, along with consultancy to develop small businesses. Business Correspondents without consultancy services may just offer debt finance and increase indebtedness of the poor in the unorganized sector, whereas if consultancy services are provided along with equity finance, it may help the poor and vulnerable to proficiently use the finance.

6. We need to develop ‘Market for Unorganized Sector Small Equity Finance and Investments (MUSSEFI)’ where small banks and financial institutions could deal with small mutual funds or venture capital funds focussed on the unorganised sector. This would help equity market to grow out of the present situation in which over 90% Indians do not have any share in equity market. MUSSEFI would work as an OTC market for equity and debt instruments. There would have to be some market makers which could be found from a number of Islamic Financial Institutions dealing in equity financing.

7. There should be a specified category of deposits which can be used for equity finance. Such practices will help us grow investment in the unorganised sector. Such deposits could also be counted towards the equity of Cooperative Credit Societies, relieving them of capital constraints while ensuring they remain capital adequate.

8. In the unorganized sector only 12% retailers have access to formal credit system. Similarly 73% of farmer households have no access to formal credit system. More acutely 40% workers of unorganized sector have no entrepreneurial assets to provide collaterals for credits. We need to ensure that these enterprises should get cheaper and easy credits from formal sources; utilize those credits to compete with organized sector and be part of inclusive growth.

9. If Government diverts the allotted subsidies for the welfare of farmers, MSME and BPL towards equity finance or risk funds for the unorganized sector, it would help in reducing the deficit of the Government while also benefiting the poor and vulnerable sections through equity finance for the development of enterprises.

10. There should be a Public Corporation to promote industrial and retail infrastructure for the unorganized sector workers so that they could compete with the organized sector manufacturers and retailers. Industrial estates and retail markets could be developed and provided on lease finance to the unorganized sector workers; it would help them get organized.

“A National Mission on Financial Inclusion (NaMFI) comprising representatives from all stakeholders may be constituted to aim at achieving universal financial inclusion within a specific time frame. The Mission should be responsible for suggesting the overall policy changes required for achieving the desired level of financial inclusion, and for supporting a range of stakeholders – in the domain of public, private and NGO sectors – in undertaking promotional initiatives.”

12. The Justice Sachar Committee Report hints that there is annual loss over Rs. 22,000 crores to Indian Muslims due to the gap between the credit deposit ratios by them. Around 29% of the savings of Muslims are diverted as credit to others. The credit share to Muslims through SIDBI is reported to have just 0.48%. There should be a regulation to ensure fair and justified credit disbursement by Banks and financial institutions.

13. We should arrange a national level study to identify factors responsible for financial exclusion because till date we have no comprehensive study on financial exclusion so that the real barriers for financial inclusion could be broken down.

D. Islamic Banking – An alternative financial system
14. We have to recognize the fact that ‘Interest’ which is an important ingredient of our financial system, has been strictly prohibited in Islam. This is having a dampening effect on Indian Muslims’ participation in the financial system, which is evident from the Sachar Committee Report. Like ‘Financial Services Authority’ of U.K. regulating Islamic Bank of Britain, Indian regulators should also authorize the establishment and regulation for Islamic Banking and Finance in India

15. To promote public-private-partnership (PPP), we should have a national authority to design equity products and market it in national and international market. If it makes Shariah compliant equities, it could comfortably be marketed in Islamic nations. To make it feasible we need to develop a National Board for Islamic Finance, which should comprise of Government officials, financial consultants, bankers and also Islamic economists so that Shariah compliant certificate could be issued by the board at the national level and products could be sold in the national and international markets.

16. There is a sense of deprivation among Indian Muslims that many national and international banks have windows of Islamic banking abroad, but Indian Muslims are still deprived to take advantage of Islamic Banking in India. Since, we need to open Islamic Banking in oil producing Islamic nations, it would be better to first allow Islamic banking in India and open its foreign branches in abroad. Islamic Banking should not be seen as a concession to the Muslim community, instead it should be seen as a progressive step in the financial sector, which will have a vast impact on resource mobilization and financial inclusion.

E. Improvising the Information System for Financial Sector
17. National level unique ID number must be issued to every citizen irrespective of number and nature of accounts in different banks or institutions. All transactions should be traceable through that unique ID number and no significant cash and capital account transaction should be permitted without that unique ID number. That ID should be denoted at national level and not on sector or segment level so that it could be recorded that a particular ID number is involved in how many sectors, segments, enterprises or unit based transactions.

18. We should take land reform as the next most important item on the agenda because without computerization of land records, we cannot assure success of financial sector reforms. It is important to computerize all capital assets including land with specific unique asset ID number. Only then we should go to make efforts for financial sector reform otherwise chaos will always be there and vulnerable group will be excluded in the absence of relevant data and verification system.

19. We need to develop capital accounting system for individuals and firms in banks to record capital assets (lands, equity, tools, vehicles, machineries, equipments, security & certificates etc.) This would help us evaluate assets of all individuals, firms and thereafter at the national level. If managed properly, such capital accounts may also work as collaterals against equity finance. The provision to maintain cash and capital account system in banks for individuals and firms will help banks maintain required liquidity and utilize maximum financial resources through lending and equity finance.

F. Increasing Circumference of Public financial resources-
20. There should be incentive provision for regular and honest tax payers. The tax payment history of individuals and firms should be available for access by creditors and it should be considered for providing equity finance to individuals and firms. Persons and companies paying regular taxes should have advantage in availing equity finance for their honestly and regular payment of taxes. Whereas the tax savers and cheaters should have disadvantages in equity finance. This would popularize tax payment and increase Government revenues.

21. The tax revenue department should assist National Mission for Financial Inclusion by providing trading and stock keeping software free of charges to unorganized sector enterprises and allowing banks to maintain it with help of Business Consultancies, so that all transactions in unorganized sector could be well recorded and monitored by special Banks for the unorganized sector. It would help collecting taxes from unorganized sector as well. If tax revenue department successfully help National Mission for Financial Inclusion to attain 100% financial inclusion in unorganized sector, it may result additional 10% GDP growth through tax collection from unorganized sector itself.

22. The Department of Economic Affairs need to frame programmes for economic development of the unorganized sector enterprises. Software related to Sales Taxes and Excise duties may be provide through Business Correspondents, to maintain accounts of the unorganized sector enterprises. This would help the unorganized sector enterprises maintain their accounts; in turn tax revenues may increase and against tax payments, enterprises should have advantages to get tax credits.

G. Liberalizing Regulatory Norms for Financial Sector Growth
23. There should be greater liberalization related to bank licensing, branches, deposits and credit so that the financial sector could grow with comfort and facilitate economic transactions.

24. Priority Sector Lending was introduced at a time when we had limited resources and we needed to ensure that scarcity of resources did not affect the priority sectors. After liberalization, we no longer have such scarcity of financial resources. There is no longer any need for stimulating financial flows into priority areas. Thus we do not find any reason to continue PSA system or to advance it with PSLC scheme because it has no economic rationality in liberalized economy; rather it often creates NPAs. Farmers’ loan waiving over Rs. 71,000 crore is in fact a side effect of PSA scheme.

25. All Banks and NBFCs or other financial institutions should have equal rights and the regulations should ensure level playing grounds. Government should not have any share in Banks because it does not positively affect the efficiency or growth of Banks. All banks should have freedom to choose their own board members or to extend branches or network with other financial institutions without any regulatory restrictions. RBI should allow banks to work according to market forces and decide their rate of interest or percentage share in equity capital. The economic rationality and liquidity should be allowed to govern the financial market.

26. It is not evident that SLR really helps achieving stability or growth of financial sector; on the contrary, it is evident that it enables deficit finance by government and causes inflation. Thus the condition of SLR should be omitted because it may restrict growth of banks in the unorganized sector. The condition of minimum capital should be liberalized for new banks for the unorganized sector otherwise it may restrict smaller but innovative entries into financial market. Like small community banks in USA, we may need to promote Community Based Multidimensional Local Area Small Banks and Financial Institutions for our unorganized sector to make financial inclusion a success with cost efficiency.

27. The ‘Hawala Agencies’ and ‘Angaria’ are in fact catering to real financial needs and so it is better that the regulations for registration, licensing, networking and transaction should be liberalized with minimum tax slab so as to induce illegal financial players to undertake only legal financial transactions. It would reduce money laundering business and increase tax revenue of the Government.

I wish the final report of CFSR would contain proposals to develop banking and finance among poor and vulnerable associated to unorganized sector and also open door for Islamic Banking and Finance. Wishing that the proposals would be taken up for implementation at it’s earliest and enable Indian financial sector grow at a much higher rate.